If Only Gold Were Our Currency!

Wish we were on a gold standard? Think again.

When you post any thoughts about gold, you're inevitably going to end up with some folks who bring up the currency issue. "Gold is a currency," they say. "Gold has been favored since the time T-Rex ruled supreme (the dinosaur, not the band)." And of course, "Gold is going up because our fiat money is being debased and rational people are doing the only thing that makes any sense by buying yellow metal."

One commenter, for instance, posited: "Gold is trading as a currency. Yes it could be somewhat overvalued today, and may fall back, but in 12 months it will be up against all fiat currencies that are clearly being devalued."

But here's the problem: If gold is acting like a currency, it's acting like a really, really bad one.

In my article last week, I provided a plethora of charts showing how gold's price action has stacked up against a variety of actual goods including milk, cotton, and pork. If gold were truly acting as a currency and reacting simply to the paper currency being injected into the system, gold's price would simply track the price of things that people actually buy -- like milk, cotton, and pork -- as everything simultaneously rose drastically in dollar terms.

This would make perfect sense to me, because as the perfect currency, I should be able to expect that an ounce of gold today will buy roughly the same amount of pork that an ounce of gold did back in 2000. But that's not nearly the case. In 2000, an ounce of gold would have bought you 108 pounds of pork. Today, it will buy you 535 pounds. That's a happy outcome for someone who has gold and loves bacon, but it doesn't make for a good currency.

Many of the people who would argue for gold as our actual currency contend that it would fight the financial ill of inflation. That's a fair point, and it seems to do that in spades. However, just as rapid inflation can cause serious economic problems, rapid deflation can cause major problems of its own.

In a deflationary environment, the pork farmer selling all of that bacon above would have to consider lowering his prices year after year. Why? Because if the price of everything else is falling in gold terms, he's going to have to keep his prices in line or risk having overpriced meat products that are getting smelly as they sit unsold in his warehouse. More notably, large pork farms will have to continually renegotiate labor and other supply contracts down since the product they're selling is continually falling to a lower price. The Austrian School of Economics -- which is often behind the calls for gold as a currency -- is noted for its focus on the role of human psychology in markets, so surely it would understand the psychological friction involved in continual downward contract renegotiations.

The ant and the grasshopper revisitedOf course the group that really benefits in the "gold as currency" scenario is the savers in the economy. You're a pretty happy camper if the (gold) currency that you're stuffing under your mattress is increasing in relative value year after year. That's in stark contrast to the current reality where inflation -- no matter how low it is -- continually eats away at the value of your cash.

On the flip side in this world of gold currency, debtors would be in terrible shape. In a deflationary environment, the value of the principal that they owe would be constantly increasing on top of whatever interest they're paying for the use of that capital.

"Fantastic!" gold proponents are likely to say. "That's just how it should be -- savers are rewarded and debtors are punished. We currently do things the opposite way, and look where it's gotten us."

That's a pretty attractive viewpoint because it seems to make logical sense. But here's the problem: A savings-oriented culture where people are scared to borrow is the enemy of a growing economy. When your economy is rewarding the Scrooge McDucks of the world who are perfectly content hoarding their gold coins in a giant vault where they can take afternoon swims, while causing gung-ho entrepreneurs to wet their pants at the thought of taking on debt to expand their small business, you've got problems. Unless, of course, you don't really care about economic growth.

It's pretty easy to look at the unemployment rate, the terrible performance of the Dow Jones (INDEX: ^DJI) and other market indexes over the past decade, and the sluggish economic growth and conclude that something drastic needs to change. I think that's true, but I think that change needs to come in the form of better education and training, less political rancor, and a willingness to find common-sense solutions to big problems like Social Security and Medicare.